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Interest rate risk hedging demand under a Gaussian framework

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Abstract

This article analyzes the state variables Merton-Breeden hedging demand for an investor endowed with a utility function over both intermediate consumption and terminal wealth. Based on the three-factor model of Babbs and Nowman (1999), we show that this demand can be simply expressed as weighted average zero-coupon bonds sensitivities to these factors. The weighting parameter is actually the proportion of wealth our investor sets aside for future consumption rather than for terminal wealth.

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  • Attaoui, Sami & Six, Pierre, 2010. "Interest rate risk hedging demand under a Gaussian framework," Journal of Financial Transformation, Capco Institute, vol. 28, pages 103-107.
    • Handle: RePEc:ris:jofitr:1419
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    Keywords

    Merton-Breeden hedging demand; interest rate risk; expected utility maximization; intermediate consumption; terminal wealth;
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    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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